The 2008 credit crisis had its roots in sub-prime home loans offered to those who could not afford to service them. Lenders reassured themselves the US would never suffer a nationwide housing crisis. Well, it did.

Problems for securitisations containing a rich mix of sub-prime and derivatives forced governments to rescue the global banking system. High bank exposures to overpriced Irish and Spanish real estate contributed enormously to the 2010 eurozone crisis.

The good folk at Davos came down from the Swiss mountains last month, declaring collapse has been averted – which is good news, if true.

Strategists are now watching out for the next real estate bubble, even if they can’t stop it inflating.

Their biggest worries centre on China, in the wake of unprecedented public sector expenditure on real estate and infrastructure.

Investment spiralled out of control when Beijing told local authorities in 2009 to invest to save China from the western credit crisis. To meet their targets, councils borrowed as much as they could from banks, then borrowed through off-balance funding vehicles to raise trust loans worth RMB 6 trillion ($1 trillion) from investors hungry for yield.

Promoters went on to find their funding opportunities through wealth-management products where different debt securities were put into instruments offering two percentage points more than low-yielding bank deposits.

If you think these clever things resemble a collateralised debt obligation, you’re right. They rose in value by a fifth to RMB 13 trillion in 2012, according to rating agency Fitch & Co.

In a research note, Edward Chancellor and Mike Monnelly of US asset manager GMO said of China: “Too much credit has been created too quickly. Too much money has been poured into investments unlikely to generate sufficient cash flows to pay off the debt.”

Half China’s annual gross domestic product is made up of real estate and infrastructure. Official data suggests unfinished housing stock is equivalent to 20% of GDP. You can imagine the financing headache that can cause.

Ghost towns are littered across the country. If you go to YouTube, you can view the empty boulevards of Ordos, Inner Mongolia, topped off by a huge statue of Genghis Khan. The city has a million apartments, quadruple the size of the local population.

According to GMO, public sector debt, on and off council balance sheets, is close to 90% of GDP, the point at which servicing costs can lead to economic decline.

Investors who financed this real estate revolution started out assuming their money was safe, not least because several wealth products were distributed by the banks. It remains to be seen whether investors will remain so sanguine now doubts over the quality of collateral and credit guarantees have increased.
Asset manager First State says: “We would not rule out significant mis-selling problems down the line.”

As early as 2011, the city of Wenzhou fell victim to a series of defaults hastily sorted out by the government, permanently alert to the danger of popular unrest.

To make funding available, banks have started to roll over their direct loans to local authorities. They may also carry the can for wealth products. The government could help by loosening bank reserve ratio requirements. State-owned debt clearance specialist Huarong Asset Management recently rescued two trusts on the verge of defaulting.

The big issue, however, relates to the risk that Beijing will lose control of the credit system. In the China Daily, Xiao Gang, chairman of Bank of China, said: “Money has flown out of bank savings deposits, eroding the capabilities for lending to the real economy.”

Shadow banking, he added, is funding half-built projects: “A lot of money has become involved in property speculation.”

The system of “red capitalism”, where Chinese authorities directed savings for the country’s development is under threat, as local government moves up the rescue queue, usurping other projects.

Disturbed by recent developments, investors are starting to move capital overseas. The growth in China’s reserves has fallen to zero, according to Russell Napier, of stockbroker CLSA Asia-Pacific.
In the circumstances, the Chinese Central Government’s decision to reform and open up its capital markets to more western investors is less than surprising.

New sources of finance will be sorely needed to finance its industrial base and refinance its debt as local governments continue to request funding. Huarong has indicated it intends to float in 2015. Its rival Cinda Asset Management also plans a listing.

China is presumably big enough to deal with the problem. It retains significant investments in US Treasury bonds.

The opening of the Chinese market will offer plenty of opportunities and the approaching year of the snake is said to be good for business.

However, according to one online guide, “it is important in the year of snake to plan everything beforehand, and evaluate adequately before taking any actions”. Quite so.